ABU DHABI // If one thing is clear, it is that the outlook for global inflation - whether it is getting better or growing worse - is getting muddier. Saudi Arabia's monetary agency said last week that it expected inflation this quarter to keep accelerating due to housing shortages, government spending and increased personal consumption during Ramadan. But it said it expected inflation to increase at a more moderate pace.
In India, the commerce ministry announced that inflation in the week to Aug 16 was slightly lower than many economists expected. But inflation was still above 12 per cent, thanks to heavy rains that hurt grain harvests. In Japan, which for the past 20 years has battled against deflation, inflation accelerated to above two per cent for the first time in a decade. And in Europe inflation in last month remained above the European Central Bank's target of two per cent or lower, but it eased to 3.8 per cent from four per cent the month before. A growing number of economists have been predicting that the spreading global slowdown would pull inflation down, allowing monetary authorities to turn from fighting inflation to staving off recession. Yet mixed signals over whether inflationary pressures persist and how long they will do so have sparked a debate between economists and central bankers about whether or not it is too early to declare victory against inflation.
Which way inflation is headed and how central banks respond to it is of vital importance to the global economy. Underestimate the threat of inflation and central bankers risk allowing workers to develop expectations of price increases into wage demands, the dreaded wage-price spiral, reducing the value of workers' savings and corporate profits. Overestimate the threat of inflation and they risk tightening the money supply and worsening the impact of the global slowdown, resulting in more job losses and greater pain.
The confusion over the pace of price increases goes to the very centre of the global economic turmoil - the United States - and to the powerful regulator struggling to bring it to heel. "The committee expected inflation to moderate later this year and next," said the Federal Reserve's Board of Governors in the minutes of its meeting Aug 3 and released last week. "However, in light of the continued increases in the prices of energy and some other commodities and the elevated state of some indicators of inflation expectations, uncertainty about the inflation outlook remained high."
Even America's most respected messengers cannot seem to determine just which way inflation, or the Fed, will go. The Wall Street Journal read the Fed's minutes and concluded that it had "little inclination to raise interest rates in the coming months". The New York Times, on the other hand, told readers that "Federal Reserve policymakers expect to eventually raise their benchmark interest rate in an effort to slow inflation."
Analysts say investors have already been punishing emerging markets for failing to raise interest rates in response to soaring inflation. "In spite of inflation risk, central banks delayed or even prevented monetary tightening and currency appreciation in order to support growth as they feared exports would take a hit from a US slowdown," said Arpitha Bykere, a lead analyst for international trade at RGE Monitor. "Delayed policy responses to cope with inflation and its impact on growth has raised concerns among foreign investors leading to stock market decline and capital outflows in many countries."
That has helped fuel a dollar rally as investors pulled funds out of emerging markets in favour of the safety of dollar-denominated assets such as US Treasuries. The foreign selling has been so intense that some Asian central banks had to take the extraordinary measure of selling dollars to buy their own currencies - they usually do the opposite to keep their currencies from rising with their trade surpluses.
The exodus has shown up in stock markets. Foreign investors pulled US$2.2 billion (Dh8.1bn) out of stock markets in Asia excluding Japan last week, according to Nomura International. Likewise, foreign investors were net sellers of Dh549 million worth of stock on the Dubai Financial Market last week, which included roughly Dh108m in net sales by Gulf and other Arab investors, according to the exchange.
"Hedge funds are moving out of emerging markets and into liquid markets," said Mahmood al Aradi, head of financial markets at National Bank of Abu Dhabi. "A lot of money has shifted very quickly out of this region." While accelerating inflation in emerging markets was once a symptom of quickening economic growth, inflation now appears to be exacerbating the economic slowdown. Indeed, in many Asian economies, real growth (nominal growth minus the inflation rate) is already negative.
In this stagflationary environment, however, few central bankers seem willing to risk slower growth to fight inflation. The Bank of Japan has for the first time in a decade described Japan's economy as "sluggish", which analysts said indicated it is unlikely to raise rates in response to rising prices. China is reportedly readying a 370 billion yuan (DH199bn) stimulus package to fend off a post-Olympics slowdown. Inflation, led by skyrocketing food prices, has dropped to its lowest in 10 months amid falling prices for grain and oil, but it is still running at 6.3 per cent. Analysts predict that rather than raise rates or curb spending, China is likely to allow its yuan to appreciate, taking advantage of weak export demand to lower import prices.
Even notorious inflation hawk Jean-Claude Trichet, the ECB's president, described the European economy last week as "particularly weak", sending bond prices higher on expectations that even he will not have the heart to raise rates in the current environment. @Email:warnold@thenational.ae